Twenty-five is not the limit but...
In 2016, the Australian economy recorded its 25th year without recession. Markets wobbled in 3Q2016 when real GDP contracted by -0.5% q/q. But anxiety eased when GDP rebounded to growth in Q4 (+1.1% q/q) thanks to a supportive economic policy mix, improved external demand and a better commodity prices environment.
Going forward, economic activity is set to grow by around +2.7% in 2017. Meanwhile, signs of a cyclical upturn have built up in the first two months of 2017.
Firstly, stronger demand growth from Australia's main trade partner China and a rise in commodity prices have boosted expectations on exports and industrial performance. Secondly, domestic demand growth is set to remain firm supported by a supportive policy mix. While the central bank and the Australian Prudential Regulation Authority will focus on reducing financial risks, fiscal policy will remain expansionary to keep growth in an acceptable range.
Private expenditure is also set to recover gradually. Households will probably be more cautious on their spending habits due to their high leverage, however private investment is set to recover supported by favorable fiscal policies and rising new exports orders. Against this background, we expect corporate insolvencies to decrease by -2% in 2017 (after -19% in 2016).
Risks to the outlook remain elevated, though. Domestically, high household debt and high house prices have increased financial vulnerabilities and will probably be the main focus of Australian financial authorities in the short run. Externally, the outlook will heavily depend on China’s economic performance.
All eyes on China
China accounts for 32% of Australian goods exports. The Mainland is the biggest market for items including Australian mining, energy and agricultural products. Trade and financial links are on a rising trend with stronger services trade and rising investment flows between markets. In the longer term, ties with the Mainland could further increase with the Regional Comprehensive Economic Partnership.
How China fares will be key
In 2017, China’s GDP growth will remain above +6% thanks to strong public support and solid private consumption. Exports and private investment will underperform. Services will remain the main driver of the economy, while the manufacturing sector will continue to restructure.
Targeted policy weapons will be pivotal to countering external threats.
The authorities’ ability to support growth through credit has deteriorated. For each RMB1bn of additional growth, there was RMB1.8bn of additional domestic credit in 2011. It now stands at RMB3.6bn. As credit was not used to finance productive investments the impact on economic activity has diminished. Investment efficiency has also worsened. In 2016, 6.6 points of capital were needed to generate 1 unit of additional GDP, while in 2005, only 3.5 points were required.
Improving the efficiency of macroeconomic policies will be pivotal in the longer term. First, this will help reduce the reliance on debt. Corporate debt has increased by an average of 10 points of GDP per annum since 2012. Second, improving the return on investment could help to keep savings and capital in China. At least USD500bn left the economy in 2016.
As a consequence, authorities are expected to focus on the following five Cs in 2017-18:
- Promote Credibility. Improving investors’ faith in government policies will be pivotal to avoid volatility, maintain adequate capital inflows, and support private investment. Clear communication and a reasonable GDP growth target of +6% ± 0.5pp in 2017 will be key. We expect the economy to expand by +6.3% in 2017.
- Contain Credit risks. Corporate debt accounts for 170% of GDP and corporate bankruptcies are set to increase by +10% in 2017 (+11% in 2016). A tighter monetary stance in 2018 could lead to a gradual deleveraging. Meanwhile, the fiscal stance will remain accommodative to support growth.
- Reduce excess Capacities in the production of basic materials. This task will be tackled through a stepby-step approach. New orders will likely be weak with more protectionist measures overseas and a tightening property market. But supply growth will likely adjust at a slow pace as authorities prioritise employment over overcapacity reduction. Reforms of State Owned Enterprises (SOEs) – which are major suppliers – will likely be gradual too.
- Manage the Currency. The RMB could remain at around 7RMB per USD in 2017. Pressures could mount due to a diverging monetary policy with the US, less favorable news, and higher returns on investment abroad. In this context, the authorities may pursue currency internationalisation but at a gradual pace to minimise the impact on growth. They would intervene in Forex markets to limit sharp adjustments of the currency, use temporary capital controls, and initiate tighter regulation to limit the pace of capital outflows.
- Tweak the Commerce strategy. USD-denominated goods exports decreased by -7.7% in 2016. The US, which accounts for 18% of China’s exports, may increase trade barriers. China will seek new commercial drivers: a price competitiveness boost (Market Economy Status), new customers and new investment revenues (One Belt One Road), strong partnerships and political influence (the Regional Comprehensive Economic Partnership).
Creating its own league to promote and finance growth rebalancing
China’s rebalancing has already started to impact sectors and countries around the world. Going forward, established semi-finished goods producers – Hong Kong, Taiwan, Singapore and South Korea – along with longtime industrial commodity suppliers, will continue to feel the pinch. On the positive side, Asia’s low value-added retailers, as well as high value-added Western producers, could benefit from China’s new economic model.
The failed attempt to get Market Economy Status and slated protectionist measures from the US could mean retaliation and heightened political tensions between the two biggest economies in the world. The EU and Japan are expected to make concessions to preserve trade relations. As a consequence, China is expected to accelerate its outside influence agenda. (i) The One Belt One Road initiative has already kicked off with projects in Pakistan and East Africa. (ii) An agreement could be reached on the Regional Comprehensive Economic Partnership, a free trade agreement between ASEAN Members, Australia, New Zealand, India, Japan, South Korea and China. And (iii) on the currency front, the RMB internationalisation as a means of payment and as a reserve currency could gather steam in 2017.
Facing severe increases in counterparty risk, a sound knowledge of your customers and the market in which they operate is the critical foundation of any good credit management. Protecting your trade receivables and using professional help in collecting payments will be crucial to boosting your bottom line.
*Chris Doube Australia and New Zealand CEO Euler Hermes www.eulerhermes.com
EulerzHermes is the global leader in trade credit insurance and a recognised specialist in the areas of bonding, guarantees and collections. With more than 100 years of experience, the company offers businessto-business (B2B) clients financial services to support cash and trade receivables management. Its proprietary intelligence network tracks and analyzes daily changes in corporate solvency among small, medium and multinational companies active in markets representing 92% of global GDP. Headquartered in Paris, the company is present in over 50 countries with 6,000+ employees. Euler Hermes is a subsidiary of Allianz, listed on Euronext Paris (ELE.PA) and rated AA- by Standard & Poor’s and Dagong Europe. The company posted a consolidated turnover of €2.6 billion in 2016 and insured global business transactions for €883 billion in exposure at the end of 2016. Further information: www.eulerhermes.com, LinkedIn or Twitter @eulerhermes